Your credit score should not be a mystery. Although there is no verifiable statistic to prove my theory wrong, I would imagine many people don’t know their credit score or what makes it go up and down. The fact that credit reporting agencies don't readily reveal their calculation methods makes it easy to see why people are in the dark about it. You may not need to know the exact formula, but it's still wise to understand how they come up with your credit score so you can whatever be possible to maintain or improve your score.
I always say knowing is half the battle. After all, if you don't know what goes into your credit score, there is no real way to do anything about it. Arming yourself with a little more information about what elements go into determining it and how it's calculated allows you to have more control over your financial health and guide your financial journey. With that in mind, here is an outline of what the credit score is made of:
1. The most essential part of your credit score is your payment history. Believe it or not, this counts for a staggering 35% of your overall credit score. Now, if you have a spotless record of making payments on time, then this is good news. On the other hand, if you occasionally need to remember to pay a bill and are routinely a few days late, this could be bad news. I say 'could be' because different creditors have different policies on when they will report a late payment to the credit agencies. Regardless, you don't know what that threshold is, so it's best to pay all your bills and loans on time.
2. Your diversity of credit types adds up to 10% of your score. Having a mortgage, car loan, credit card, and maybe even a store account that you pay on is a sign to the agencies that you can handle various credit options. Be sure you can handle all of them, though, as not paying on time for even one type can count against you.
3. 15% of your credit score is determined by the length of your credit history. Of course, the better you have handled that credit over the years, the better it will be for your score. But it's still better to have a more established credit record than a shorter one.
4. Second strongest factor on the list, next to your payment history, is the total amount you owe. This factor accounts for 30% of your score. The total amount you owe is compared to your income in what's known as the "debt to income" ratio. The lower, the better. You should aim to keep your total debt at 25% or less of your annual income to have the best effect on your rating.
5. New inquiries, specifically hard inquiries, into your credit account for 10% of your total score. For the bureaus, new inquiries are a warning sign that you may be overextending yourself and your debt-to-income ratio. One thing to keep in mind is the exception of soft inquiries. They don’t affect your score. An example of a soft inquiry is when you are looking at your credit report from Credit Karma.
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